Owners' mixed lot: Doing their part via revenue sharing

Owners' mixed lot: Doing their part via revenue sharing

Please bear with the length of this article; it’s the longest of our series and concerns a very important topic. While not an official deal point between the NBA and NBPA because revenue sharing is a matter to be negotiated among NBA franchisees (NBA owners), the NBPA could make its own agreement as to CBA terms conditioned upon greater revenue sharing among NBA owners.

In my introductory blog, I made the case that the players clearly “won” in the 2005 Collective Bargaining Agreement, at the clear expense of many owners. In order to arrive at a fair compromise for the next CBA, players will likely cede some of the ground that they gained in the last CBA and accept some scaling back of their guaranteed stake in league revenues (also known as BRI, or basketball-related income). This blog, however, will explore what the concept of revenue sharing as it exists presently in the NBA and how it might be expanded to help ensure profitability across all NBA franchises.

Revenue sharing is a process by which a league’s teams redistribute revenue. One form of revenue sharing might be to tax and redistribute all teams’ profits above a certain dollar amount. The drawback of such a scheme is that efficiently operating teams will be forced to subsidize other franchises, who might be failing because of the franchise’s own poor decision making. Such a scheme could result in less motivation for any given team to maximize its own profits; effectively, a freeloading mentality could be fostered.

The NBA’s revenue sharing is more limited than the NFL’s or MLB’s, where sharing works to negate league disparities in media market size. Along with many other forms of sharing, the NFL engages in vigorous sharing of gate receipts (60/40 for the benefit of the home team whereas the home team enjoys 100 percent of gate receipts in the NBA) and MLB makes each team’s local TV revenues subject to revenue sharing. NBA revenue sharing is mostly limited to the sharing of revenues from national TV, licensing, digital rights, merchandising agreements, and the topic du jour, the luxury tax.

The luxury tax is a tax that is applied to all NBA teams whose player payrolls exceed a certain threshold ($70,307,000 in 2010-11). For every dollar that a team spends on salary above that threshold, the team pays a $1 tax, and the total tax money collected from all luxury tax paying teams is divided by 30 and distributed equally among non-paying teams. It is important to note that this is actually a tax on a team’s competitive advantage (supposedly derived from having a higher-priced payroll) and not a tax on a team’s profits. As such, teams paying the luxury tax may actually be sustaining negative net operating income. Also worth noting is the fact that, in the current system, teams spending anywhere from $50 million up to $70 million all pay the same tax (zero) despite the fact that their likelihood of being competitive is quite disparate.

The ultimate, over-arching goal of the NBA as a business should be to ensure a league where owners in all NBA cities can field competitive teams, earn fair profits, and fairly compensate their employees. The MLB’s revenue sharing model goes too far in supporting small-market franchises that refuse to commit themselves to being competitive. For example, the Pittsburgh Pirates last made the playoffs in 1992, nearly 20 years ago. A large part of the team’s lack of success is ownership’s unwillingness to spend on its roster. Despite revenue sharing payments of $35 million in 2009 and $39 million in 2008, the Pirates habitually fail to match revenue-sharing dollars with ownership’s own in paying for the team’s roster. Resultantly, the team struggles on the field but continues to reap annual operating income in the range of $15.6M (for 2009 and 2010, per Forbes Magazine).

This system is the polar opposite of the present NBA system, one in which qualifying teams receive a meager $3-4 million from the luxury tax. In devising an ideal revenue sharing model, the NBA and NBPA should seek a happy medium between the NBA’s current model and the MLB’s model.

In arguing for less drastic cuts in player salaries during collective bargaining discussions, the NBPA will point to the many NBA franchises that pay eight-figure annual salaries to their players as evidence that the NBA’s plight is not as bad as David Stern would suggest. A fallacy in this argument is that NBA owners may feel a need to sign and possibly even overpay a superstar or simply a star (i.e. Atlanta’s signing of Joe Johnson) in order to keep the team in contention, thus keeping the fanbase excited, and thus hopefully resulting in less drastic operating losses for ownership.

Both the NBA and NBPA are right about the NBA’s financial situation: It’s both every bit as bad as advertised by Stern, and it’s not a problem whatsoever… It all depends on what team we’re talking about.

If some teams are already profitable, and if some teams are losing money hand over fist, then an adjustment to guaranteed BRI that would make even the biggest losers profitable would have a windfall benefit for profitable franchises and would come at the unfair expense of NBA players. Even if the NBPA did recognize that some NBA teams are losing money and that reductions in players’ salary could help in ensuring profitability to the league, they would be right to inquire about what the NBA’s profitable teams might do to help ensure fair profitability for all.

As mentioned above, it is important to distinguish between taxes that attempt to neutralize market size as a determining factor in revenue generation (i.e. tax on or sharing of local TV revenues) and taxes that seek to neutralize excessive competitive advantage (i.e. the luxury tax). Small market owners losing games and losing money would favor revenue sharing that increases their ability to not only profit but also compete. Revenue sharing that allows teams losing money to merely be profitable (i.e. sharing a new stream of revenues, such as home team’s gate receipts) won’t do much for making the franchise more competitive so long as rich owners in large markets can continue to rampantly exceed the luxury tax threshold with little ramification (relatively speaking). A pure handout such as this is like giving a man a fish rather than teaching him to fish.

The NBA business model assumes that all franchises are located in cities that can support sold out arenas and can make for profitable franchises, presuming that the franchise offers an exciting product. Rather than simply hand out cash to perennial losers, part of the goal of revenue sharing should be to make it possible for all teams to field teams who could contend for a title. While it’s unlikely that the NBPA would assent to a hard cap (unless it was set very high), a harder cap and a luxury tax with more teeth might serve well to both increase both revenue sharing and parity. As all teams become truly able to compete, more fanbases at any given time will have hope and invigoration (either ascending with hope or riding the exhilaration of recent success), and all 30 NBA markets will be more able to succeed without leaning on others.

At present, the luxury tax is set at $70.3 million, and eight teams are presently in line to spend a combined $108 million in luxury taxes. This $108 million would be divided by 30 and distributed to the 22 non-paying teams, who would receive just north of $3.5 million each. The rest of the money goes to the NBA for “league purposes.” With some teams claiming annual operating losses in the $20 million range, this amount is a drop in the bucket.

In my previous blog,I advocated a compromise system whereby a harder soft cap would be set at a dollar figure that most teams, if run well, could meet, profit at, and win at. Assuming for purposes of example that this figure is set at $70 million, the only way that a team could spend substantially above the cap would be by signing a “franchise player” under the Bird Exception (only one player would be allowed to be under a contract made possible via the Bird Exception for each team at any given time).

Rather than employing the current luxury tax system, the NBA’s owners should strongly consider a luxury tax that would (a) be more costly to those who exceed the luxury tax threshold, and (b) award luxury tax proceeds to teams in an inverse relationship to their annual payroll. Specifically, in the event that teams continued to exceed the new, harder soft cap of $70 million, they would be met with a heavy tax (i.e. $2 per dollar over the cap). If, under this system, four large-market and/or multi-billionaire-owned teams spent in excess of the harder cap, and if each did so by an average of $10 million, the NBA would collect $80 million in luxury taxes. Rather than distribute the $80 million equally across all teams under the harder soft cap of $70 million, the funds would be distributed in a manner that skewed toward the teams spending the least on their rosters (so long as they spent above a payroll minimum).

As an example… If $80 million was collected in luxury taxes, if five teams were below $60 million in payroll, if 10 teams were at $60-65 million, and if 10 teams were at $65-70 million, then the teams with the lowest five payrolls could be awarded $6 million each, the teams with $60-65 million payrolls could be awarded $3 million each, and the teams with $65-70 million payrolls could be awarded $2 million each. This improves the current system where all non-paying teams receive the same amount despite the fact that the paying teams have different amounts of competitive advantage on each of the non-paying teams, depending on just how “non-paying” they are.

Alternatively, a formula could be created to more narrowly tailor rebates to teams based upon their exact payrolls (so that teams with payrolls of $66 million would receive slightly more than those with payrolls of $69 million).

Rather than simply giving each rebate-receiving team a hand-out and allowing them to field poor teams for decades (recall the Pirates example), the luxury tax payments could be conditioned on the teams adding at least half of the amount they received to their payroll as new salary in the following year. So if a team spent $55 million in Year 1 and received a $6 million tax rebate at the end of Year 1, the team’s salary would have to increase to at least $58 million in Year 2 in order for the team to not forfeit the rebate. If a rebate receiving team would be pushed above the $70 million cap by adding half of the luxury tax rebate to its payroll in Year 2, the requirement would be dropped and the tax rebate could be kept sans obligation.

This system pushes teams to increase their salaries up to the cap but not to exceed it unless a seriously compelling opportunity presents itself. By setting the cap and tax threshold at $70 million, a figure that many teams can afford while also being profitable (especially if competitors are not spending wildly north of the $70 million), the league’s teams can become more financially stable and the players can continue to receive salaries akin to what they have been receiving as of late. If NBA teams’ financial documents reveal that $70 million is an unrealistic payroll proposition for the majority of NBA teams, then a number somewhere south of $70 million could be agreed upon.

Under this system, it would be sensible to require that all teams spend at least $50 million on their payrolls (only two teams are south of $50 million now) since more quality players would be available due to the reduction of players being offered the coveted Bird Exception by their teams (not to mention bolstered luxury tax rebates).

A possibly negative impact of this proposal would be the fact that the few teams willing to take on luxury tax payments would still gain a competitive advantage over the teams unwilling or unable to take on the tax. At least under this system, those teams exacting a price on parity would pay more of a tax as a result.

This entire blog is premised on the assumed goal of making all 30 NBA franchises viable business enterprises. While this proposal is only a beginning, its consideration could lead to an NBA where more franchises and their fanbases have an opportunity to be energized and successful.

Matt Tolnick is an agent at Kauffman Sports. The opinions expressed in this article are not to be construed as the opinions of Steve Kauffman or KSMG as an entity. Continue following the blog series at kauffmansports.com or on Twitter @KauffmanSports.